Tag Archives: MassMutual

The Industry Needs an Intervention

Leaders in the insurance industry, like many other industry executives, are seeking routes to profitable growth amid unprecedented economic, financial and regulatory change. No longer can companies pursue top-line growth for its own sake without adverse consequences or rely on cost cuts alone to boost margins. Today, companies must strike a strategic balance that will sustain profit growth and shareholder returns over the long term.

This is no easy trick, as tectonic forces unsettle the insurance industry — which is accustomed to measuring the pace of change in decades, not years or quarters. A business-as-usual approach falters in the face of quickly shifting customer needs, rising capital requirements, new regulatory burdens, low interest rates, disruptive technology, and new competitors.

Many companies aren’t getting the results they need from textbook moves such as fine-tuning marketing programs, updating products, enhancing customer-service systems or beefing up information technology. That’s because traditional operating levers for executing strategy simply weren’t designed for the challenges confronting insurers today. Strategic success now requires something more: a structural response. A company can’t adapt to 21st-century conditions without modernizing its 20th-century structures.

The key is for companies to realize that strategy equals structure. Strategy — the big and important ways that a company chooses to compete — must naturally and intrinsically weave in key operating model dimensions, including legal entity, tax positioning, capital deployment, organization and governance.

Finally, once strategy and structure are wed, companies must recognize the role of culture in making new structures work, and use their cultural strengths to promote the changes and ensure that they have staying power. Here’s how:

Responding to the Pressures

Rapid evolutionary change has rendered time-honored organizational structures ineffectual or obsolete in many cases. Before attempting to execute new strategies, insurance companies need to reevaluate every dimension of their operating model.

Structural inadequacies take many forms. Some companies lack the scale needed to generate profitable growth under new capital requirements. Others with siloed, hierarchical organizations lack the flexibility to respond quickly to market shifts. Poor technological capabilities often hamstring old-line insurers facing new digitally oriented rivals. And tax reform and regulation looms as a potential threat to profitability in certain business lines.

See also: Why Is Insurance Industry So Small?

In our work with insurers, we at Strategy&, PwC’s strategy consulting business, have seen certain common responses to these pressures. Their responses divide these companies into three groups:

  • The first group of companies have anticipated the effects of marketplace trends and made appropriate structural adjustments, clearing the way to profitable growth. For example, life insurer MetLife avoided costly regulatory mandates by selling registered broker distribution to MassMutual and spinning off its Brighthouse retail operations. Others, including Manulife and Sun Life, have made substantial acquisitions to consolidate scale positions.
  • The second group of companies have recognized the need for structural change, but have yet to carry it out. With plans made, or under discussion, these companies are waiting opportunistically for the right deal to come along.
  • A third group of companies, however, have hunkered down behind existing structures, making only minor tweaks and hoping to emerge from the storm without too much damage. For some, this is a rational choice because of constraints that leave them with little or no maneuvering room. In other cases, action is impeded by a company culture that reflexively rejects certain options.

Companies in the first two groups are giving themselves a chance to win. But the response of companies in the third group smacks of self-delusion in an age when strategy equals structure.

Time for Real Change

Without a doubt, many insurers work diligently and continually to improve their businesses across dimensions. They gather insights into consumer needs and behaviors, nurture unique capabilities to differentiate themselves from competitors, modernize products, update distribution strategies and embrace digitization in all its forms. These are all sound approaches, but they’re inadequate in addressing the unknown facing insurers today. Their belief that they will persist assumes a certain stability in underlying economic and market conditions that hasn’t been seen since the financial collapse nearly a decade ago.

Forces unleashed by that crash and its aftermath undermined the pillars of many insurance business models. We’ve seen years of only modest growth, with property/casualty insurers expanding at a 3% pace, and life insurers barely exceeding 1%.

The long stretch of sluggish global growth has put pressure on revenues and forced insurers to compete harder on price. Near-0% interest rates that have prevailed since the Great Recession are squeezing profit margins, especially in life insurance. On the regulatory front, tougher accounting rules are driving up costs while heavier capital requirements weigh down balance sheets and dilute returns.

Compounding these challenges are the potentially destabilizing effects of tax reform on earnings and growth. Taxes may actually rise for some insurers, an outcome that could force them to raise prices or find other ways to protect shareholder returns. In many cases, the benefits of falling tax rates may be diminished by the loss of deductions for affiliate premiums, limits on deductibility of life reserves, accelerated earnings recognition and a slowdown of deferred acquisition cost deductions.

Competitive dynamics are shifting, too, as expanding “pure play” asset managers such as Vanguard and Fidelity block growth avenues for insurers. Established companies and some new entrants are innovating and experimenting with disruptive distribution models. Others, including private equity firms, are looking to bend the cost curve through aggressive acquisition and sourcing strategies.

To be sure, some long-term trends could benefit certain insurers, or at least improve their risk profile. Longer life spans and the shift of responsibility for retirement funding to individuals may drive demand for annuities and other retirement products.

However, many companies are as unprepared to capitalize on these opportunities as they are to meet long-term challenges. Often the problem comes down to scale. Some insurers lack the resources to build new distribution platforms and customer service capabilities in growing markets such as asset management, group insurance, ancillary benefits and retirement plans. Although offering an individual product may be relatively easy for new market entrants, the difficulty and cost of establishing such platforms creates a desire for scale and increases pressure on smaller competitors.

Sometimes, the issue isn’t scale but a failure to respond quickly enough as conditions change. Buying habits are changing as consumers — particularly the younger cohorts — make more purchases online. Yet our research indicates that people still want some personal assistance with larger and more-complex transactions.

It takes investment and experimentation to find and refine the right business model for new marketplace realities. But some companies haven’t built the necessary assets and capabilities or adjusted to evolving distribution patterns and consumer behaviors.

The proper response to each challenge and opportunity will be different for every company, depending on its unique characteristics and circumstances. In virtually every case, the right solution will involve structural change.

Joining Strategy and Structure

As companies recognize that traditional approaches to annual planning, project funding and technology architecture may be hindering innovation and real-time responses to changing market conditions, many are rethinking and redesigning their core processes to facilitate change. Recent transactions in the sector show the range of structural options for companies that want to advance strategic goals in a changing marketplace. Below are some examples.

Exiting businesses. Sometimes, the best choice is to move out of harm’s way; companies can preserve margins by exiting businesses targeted for higher capital requirements or costly new accounting standards. MetLife’s Brighthouse spin-off bolstered its case for relief from designation as a “systemically important financial institution,” and the associated capital requirements. Exiting U.S. retail life insurance markets also enabled MetLife to focus on faster-growing businesses that are less vulnerable to rock-bottom interest rates. The Hartford recently announced the sale of Talcott Resolution to a group of investors, completing its exit from the life and annuity business.

Partnerships and acquisitions. When scale is an issue, the solution may lie outside the company or in new structural approaches. Some insurers form partnerships to expand distribution, diversify product portfolios or bolster capabilities. Companies also adjust their scale and capital structures through mergers, acquisitions and divestitures. Sun Life paid $975 million in 2016 for Assurant’s employee benefits business, filling gaps in its product portfolio and gaining scale to compete with larger rivals. MassMutual’s purchase of MetLife’s broker-dealer network in 2016 enlarged the MassMutual brokerage force by 70% and freed MetLife to pursue new distribution channels.

Expanding into new lines and geographies. New product lines offer another path to faster growth or fatter profit margins. Several insurers have moved into expanding markets with lower capital requirements, such as asset management. Voya, Sun Life and MassMutual have acquired or established third-party asset management units to capitalize on investment expertise they developed managing internal portfolios. The Hartford recently agreed to acquire Aetna’s U.S. group life and disability business, deepening and enhancing its group benefits distribution capabilities and accelerating digital technology plans. We also see companies establishing technology-focused subsidiaries such as Reinsurance Group of America’s (RGA’s) RGAx and AIG’s Blackboard.

Cutting costs. Some companies have moved aggressively to improve their cost structure. Insurers seeking greater financial flexibility have divested assets that require significant capital reserves. Aegon unleashed $700 million in capital by selling blocks of run-off annuity business to Wilton Re in 2017. An insurer that offloads its defined-benefit plan to another via pension-risk transfer frees up capital and eliminates continuing pension funding requirements. Other cost-saving moves focus on workforce expenses. In addition to rightsizing staff, such measures include relocating workers to low-cost areas or jurisdictions offering significant tax incentives. Prudential and Manulife slashed expenses by establishing overseas operating centers that take advantage of labor cost arbitrage, create global economies of scale and reduce taxes.

See also: Key Findings on the Insurance Industry

Transformation and Culture

Once companies have launched ambitious structural initiatives, they don’t always recognize the role of culture in making the new structures work. But this is a mistake.

Culture is a pattern of behaviors, norms and mind-sets that have grown up around existing organizational structures; the two (culture and structure) are tightly linked, and you can’t change one without affecting the other. No culture is all good or all bad. But certain cultural traits are more relevant to structural change than others.

Cultural attributes affect a company’s ability to make necessary changes. A company that is consensus-driven and focused on preventing problems before they arise may be indecisive and slow to act. These traits may cause it to wait too long and miss the optimal moment for a structural transformation. Other companies, by contrast, have a tradition of quickly seizing opportunities. When this trait is supported by other important characteristics — more single points of accountability, strong leadership and an aligned senior management team — it can foster the rapid decision making essential to structural change.

Culture also comes into play after executives decide to initiate structural change. Most employees have strong emotional connections to the culture — this source of pride, along with a clear and inspiring vision of the future, can motivate them to line up behind the change and can inspire collaboration across organizational boundaries to drive the transformation. Leaders at all levels can generate momentum by signaling the desired cultural shifts and embodying the new behaviors needed to execute structural change.

A new structure without a corresponding evolution of culture amounts to little more than a redesigned organization chart. Culture makes or breaks the new structure, influencing factors as diverse as resource allocation, governance and the ability to follow through on a vow to “change how work gets done.” It’s not uncommon for a company to expend tremendous effort and resources on a complete structural overhaul, only to see incompatible cultural norms thwart its strategic execution. For example, a new, streamlined operating model intended to accelerate decision making and foster cross-functional collaboration won’t take root in a culture that exalts hierarchy and encourages employees to focus on narrow functional priorities.

Culture also influences a company’s willingness to make the deep structural changes in time to avert a crisis. Those who wait until market conditions have undermined their operating model put themselves at a disadvantage. Nevertheless, few companies attempt structural change in “peacetime.”

Absent a crisis, cultural expectations often limit directors to a narrow role monitoring indicators such as growth and profitability, while management concentrates on achieving specific strategic objectives. Under this traditional allocation of responsibilities, emerging structural issues may not get enough attention. Successful companies, by contrast, continually reassess their structure in light of evolving market conditions. They understand that organizational structures aren’t permanent fixtures, but strategic choices to be reconsidered as circumstances and objectives change.

Capitalizing on Changes

Amid the confusion of today’s insurance industry, one thing is clear: Business as usual won’t deliver sustained, profitable growth. As powerful forces reshape markets, conventional tools for executing strategy are losing their effectiveness. Today’s challenges are not operational, but structural. Many insurers lack the scale, capabilities or efficiency to compete effectively as competition intensifies, regulatory burdens increase and financial pressures rise.

Winning companies are meeting structural challenges with structural solutions. Approaches vary from company to company. Some add scale or enhance capabilities, whereas others streamline cost structures or exit lagging business lines. With the right cultural support, these structural responses position a company to capitalize on industry changes that are confounding competitors.

You can find the article originally published on Strategy & Business.

This article was written by Bruce Brodie, Rutger von Post and Michael Mariani.

Does Your Structure Fit Your Strategy?

Balancing growth and profitability is no easy trick as major changes unsettle an industry that has been used to gradual change. “Business as usual” approaches are faltering in the face of generational shifts in customer needs, rising capital requirements, new regulatory burdens, low interest rates, disruptive technology and new competitors. Many companies aren’t getting the results they need from textbook moves, such as fine-tuning marketing programs, updating products, enhancing customer service systems and beefing up information technology systems.

Strategic success now requires a structural response, and companies can’t adapt to current conditions without modernizing often antiquated structures. Before attempting to implement new strategies, companies need to re-evaluate operating model dimensions such as capital deployment, organizational design, tax positioning and governance.

In a changing insurance industry, strategic execution often requires a new structure. We recognize this is easier said than done. Structural impediments take many forms. Some companies lack scale to generate profitable growth under new capital requirements. Others with siloed, hierarchical organizations lack the flexibility to respond quickly to market shifts. Poor technological capabilities often hamstring old-line insurers facing newer, more digitally oriented rivals. And tax reform looms as a potential threat to profitability in certain business lines.

We’ve seen three common industry responses to these pressures:

  • Anticipation of the effects of marketplace trends and make appropriate structural adjustments, clearing the way to profitable growth. For example, life insurer Metlife avoided costly regulatory mandates by selling registered broker distribution to MassMutual and spinning off its Brighthouse retail operations.
    Other companies, including Manulife and SunLife, have made substantive acquisitions to consolidate scale positions.
  • Recognition of the need for structural change, but have yet to carry it out. Some companies have plans in the works, or are debating their merits, opportunistically waiting for the right deal to come along.
  • Hunkering down behind existing structures, making only minor tweaks, and hoping to emerge from the storm without too much damage. For some this is rational because they are constrained. For other companies with more viable options, company culture may be removing certain options from consideration too quickly.

Companies in the first two groups are giving themselves a chance to compete and ideally prosper. But the third group is not making strategy equal structure.

A time for structural change

Most insurers work diligently to improve their businesses across several dimensions. They seek more insight into consumer needs and behaviors, nurture unique capabilities to differentiate
themselves from competitors, modernize products and distribution strategies, and embrace digitization. These are all sound approaches, but are inadequate to address the uncertainties facing insurers today. The familiar “good to great” rallying cry assumes a certain stability in underlying economic and market conditions that hasn’t been the case since the financial collapse of nearly a decade
ago.

The crash and its aftermath undermined pillars of many insurance business models. We’ve seen years’ worth of modest industry growth – just over 3% for P&C companies, and barely more than 1% for life insurance companies.

This long stretch of sluggish global growth has pressured revenues and forced insurers to compete harder on price. Persistent near-zero interest rates are squeezing profit margins, especially in life insurance. Moreover, tougher accounting rules are driving up costs while heavier capital requirements weigh down balance sheets
and dilute returns. Compounding these challenges are potentially destabilizing effects of recent U.S. tax legislation on earnings and growth. Taxes may rise for some insurers, an unexpected outcome that could force them to raise prices or find other ways to protect shareholder returns. Substantive impacts may result from falling corporate tax rates, offset by the limiting of deductions for affiliate premiums, limits to the deductibility of life reserves, accelerated earnings recognition and a slowing down of deferred acquisition cost deductions.

Competitive dynamics also are shifting as expanding “pure play” asset managers such as Vanguard and Fidelity block growth
avenues for insurers. Other companies and some new entrants are innovating and experimenting with strategies to disrupt distribution. Still others, including private equity firms, are looking at ways to
change the cost curve through aggressive acquisition and sourcing strategies

See also: Next for Insurtech: Product Diversity  

To be sure, some long-term trends could benefit selected insurers or at very least shift the risks. Longer life spans and the shift of responsibility for retirement funding to individuals may drive demand for annuities and other retirement products.

Many companies are as unprepared to capitalize on new opportunities as they are to meet long-term challenges.

However, many companies are as unprepared to capitalize on these opportunities as they are to meet long- term challenges. Often the problem comes down to scale. Some insurers lack the resources to build new distribution platforms and customer service capabilities in growing markets like group insurance, ancillary benefits and retirement plans. While markets for individual products may be easier for new entrants, establishing expensive platforms for asset management, retirement, and group are more difficult – driving a desire for scale and putting more pressure on sub-scale competitors.

Sometimes the issue isn’t scale but a failure to respond quickly enough as conditions change. Buying habits are changing, notably through online channels (though our research indicates that for bigger and more complex transactions, most people still want help of some sort of “human” interaction before actually buying). It takes investment and experimentation for companies to try and then refine new models. Some companies haven’t built needed assets and capabilities or adjusted to evolving distribution patterns and consumer buying habits.

The ideal response to each challenge and opportunity will vary for each company, depending on its unique characteristics and circumstances. Few companies have the scale to fix all of their problems on their own. In virtually every case, the right solution will involve structural change.

Structural change drives strategic execution

The link between strategy and structure has become apparent to many management teams, particularly in life insurance. Major life insurers are taking dramatic steps to add scale, open new distribution channels, augment capabilities, drive down costs and rev up growth and, where regulation is burdensome or profit-prospects dim, exit geographies and business-lines. Recent
transactions in the sector show the range of structural options to advance strategic goals in a changing marketplace.

As companies recognize that traditional approaches to annual planning, project funding approvals, and technology architecture may be getting in the way of innovation and their ability to respond to changing market conditions in real time, they are rethinking and redesigning core processes to help the company change.

Traditional approaches may be getting in the way of innovation and the ability to respond to changing market conditions in real time.

Sometimes, the best choice is to move out of harm’s way. Companies can preserve margins by exiting businesses targeted for higher capital requirements or costly new accounting standards. For example, Metlife’s 2017 Brighthouse spinoff bolstered its case for relief from designation as a SIFI (systematically important financial
institution) and associated capital requirements. Exiting U.S. retail life insurance markets also enabled Metlife to focus on faster-growing businesses that are less vulnerable to rock-bottom interest rates. As another example, The Hartford recently announced the sale of Talcott Resolution to a group of investors, completing its exit from the life and annuity business.

When scale is an issue, the solution may lie outside the company or in new structural approaches:

  • Some insurers form partnerships to expand distribution, diversify product portfolios or bolster capabilities. Companies also adjust their scale and capital structures through mergers, acquisitions and divestitures. Sun Life paid nearly $1 billion in 2016 for Assurant’s employee benefits business, filling gaps in its product portfolio and gaining scale to compete with larger rivals. MassMutual’s purchase of MetLife’s broker/dealer network in 2016 enlarged the MassMutual brokerage force by 70%, and freed Metlife to pursue new distribution channels.
  • New product lines offer another path to faster growth or fatter profit margins. Several insurers have moved into expanding markets with lower capital requirements, such as asset management. Voya, Sun Life, and Mass Mutual have acquired or established third-party asset management units to capitalize on investment expertise they developed managing internal portfolios.
  • The Hartford recently announced an agreement to acquire Aetna’s U.S. group life and disability business, deepening and enhancing its group benefits distribution capabilities and accelerating the company’s digital technology plans.
  • We also see companies establishing technology-focused subsidiaries, like Reinsurance Group of America’s (RGA) RGAx and AIG’s Blackboard.

Still other companies have moved aggressively to improve their cost structures:

  • Insurers seeking greater financial flexibility have divested assets that require significant capital reserves.
  • An insurer that offloads its own defined-benefit plan to another via pension risk transfer (PRT) frees up capital and eliminates ongoing pension funding requirements. Other cost-saving moves focus on workforce expenses. In addition to reducing staff, such measures include relocating workers to low-cost areas or jurisdictions offering significant tax incentives.

Structural change requires cultural change (or vice versa)

Companies that launch ambitious structural initiatives may under-
appreciate the role of culture in making new structures work. Culture is a set of norms, mindsets and behaviors that have
developed around existing organizational structures. The two are tightly linked, and one can’t change without the other changing, too. Structural change will force changes to operating models and
cultural change may be necessary to drive it.

A new structure without corresponding changes in culture amounts to little more than a redesigned table of organization. Culture makes or breaks the new structure, influencing everything from resource
allocation to governance and even profit formulas. It’s not uncommon for a company to expend tremendous effort and resources on a complete structural overhaul, only to see incompatible cultural norms thwart strategic execution. For example, a new, streamlined operating model intended to accelerate decision-making and foster cross-functional collaboration won’t take root in a culture that exalts hierarchy and encourages
employees to focus on narrow functional priorities.

A new structure without corresponding changes in culture
amounts to little more than a redesigned table of organization.

Culture also influences a company’s willingness to make the deep structural changes in time to avert a crisis. Those who wait until changing market conditions have undermined their operating models put themselves at a disadvantage. Nevertheless, few companies attempt structural change in “peacetime.”

See also: Creating a Customer-Insight Strategy  

Absent a crisis, directors usually provide guidance and perspective and monitor indicators such as growth and profitability, while management takes responsibility for achieving specific strategic objectives. Successful companies, by contrast, continually reassess their structures in light of evolving market conditions. They understand that organizational structures aren’t permanent fixtures, but strategic choices they need to reconsider as circumstances and objectives change.

Implications: Is your culture ready for structural change?

Amid the constant drumbeat of change in today’s insurance industry, successful companies are meeting structural challenges with structural solutions. Approaches vary from company to company. Some add scale or enhance capabilities, while others streamline cost structures or exit lagging business lines. With the right cultural support, these structural responses position a company to capitalize on industry changes that confound competitors.

Based on our experience, companies that adjust their structures ahead of a crisis exhibit three distinctive cultural traits:

  • Directors track management’s allocation of resources against key strategic priorities.
  • Directors and managers make clear to everyone throughout the company that “the truth” is not only welcome, but expected.
  • Directors make sure the company’s talent, capabilities and know-how align with its goals.

Complacent organizations that don’t make structural changes until a crisis hits also have three distinguishing characteristics:

  • They over-emphasize “cascaded objectives” that often conflict.
  • They rely excessively on “can-do spirit” as a plan of action.
  • They exhibit unwarranted confidence in their own prescience and planning capabilities.

Which scenario typifies your organization? Are you confident your structure and culture are fit for purpose?

The Environment for M&A in Insurance

Insurance M&A remained very robust in 2016 after record activity in 2015. There were 482 announced transactions in the industry for a total disclosed deal value of $25.5 billion. The primary drivers of deals activity were Asian buyers eager to diversify and enter the U.S. market; divestitures; and insurance companies looking to expand into technology, asset management and ancillary businesses.

We expect continued strong interest in M&A, driven primarily by inbound investment. In addition, bond yields have spiked over the last few months and are likely to continue to increase. Combined with expected rate hikes by the Federal Reserve, this should have a positive impact on insurance company earnings and, in turn, will likely encourage sales of legacy and closed blocks.

However, a new U.S. president has caused tax and regulatory uncertainty that may temporarily decelerate the pace of deal activity. President Trump is expected to prioritize tax reform and changes to U.S. trade policy, both of which will have potentially significant impacts on the insurance industry. Moreover, the latest Chinese inbound deals have drawn regulatory scrutiny, and there is skepticism in the U.S. stock market about the ability to obtain regulatory approval.

See also: Innovation: Solutions From… Elsewhere  

Insurance activity remains high

While M&A activity declined somewhat in 2016 compared with 2015’s record levels (both in terms of deal volume and announced deal value), activity remained high. In fact, announced deals and deal values exceeded 2014’s levels.

Major deal trends included:

  • Asian insurers seeking to grow their footprint in the U.S. continued in 2016. Japan’s Sompo Holdings agreed to acquire Endurance Specialty for $6.3 billion, and China’s Oceanwide’s announced its acquisition of Genworth Financial for $2.7 billion.
  • Domestic companies’ expansion into new lines of business also drove deal activity, as evidenced by Liberty Mutual’s announced acquisition of Ironshore for $3 billion and Fairfax Financial’s announced acquisition of Allied World for $4.9 billion.
  • U.S. insurers, including AIG and MetLife, sought to divest noncore legacy businesses. AIG sold its mortgage insurance business, United Guaranty, to Arch Capital for $3.4 billion, and MetLife sold its retail advisor force to MassMutual, and MetLife plans to divest its consumer unit.
  • Insurers have been focused on expanding into new technology- enabled markets and products and, in many instances, are seeking to do so via acquisition. Allstate announced its acquisition of SquareTrade, an extended warranty service provider for consumer electronics and appliances, for $1.4 billion. Another example is Intact Financial’s investment in Metromile, a company that offers pay- per-mile insurance.
  • Deal volume in the insurance brokerage space continues apace. Brokerage deals, most notably the management-led buyout of Acrisure for $2.9 billion, accounted for 84% of total deal volume.

See also: How to Build ‘Cities of the Future’  

Deals market characteristics

  • Drivers of consolidation include the difficult growth and premium rate environment. In particular, there has been continuing consolidation among Bermuda insurers, notably the acquisitions of Allied World1, Endurance and Ironshore.
  • Asian insurers remain interested in expanding their U.S. footprint and accounted for two of the top-10 transactions.
  • There has been expansion in specialty lines of business, as core businesses have become more competitive. This is evidenced by:
    • Arch’s acquisition of mortgage insurer United Guaranty, which becomes its third major business after P&C reinsurance and P&C insurance;
    • Allstate’s acquisition of consumer electronics and appliance protection plan provider SquareTrade, which should enable Allstate to enhance its consumer-focused strategy;
    • Berkshire Hathaway subsidiary National Indemnity’s agreement to acquire Medical Liability Mutual Insurance Company, the largest New York medical professional liability provider (a deal that is expected to close in 2017); and
    • Fairfax Financial’s December 2016 announcement of a $4.9 million acquisition of Allied World, which the Ontario Municipal Employees Retirement System (OMERS), one of Canada’s largest pension funds, is contributing $1 billion in financing toward the acquisition (the deal is expected to close in 2017.)
  • The insurance brokerage deals space remains active and saw two of the top-10 deals.
  • Many acquirers are scaling up to generate synergies, as evidenced by Assured Guaranty and National General Holdings.
  • Insurers continue to grow their asset management capabilities. For example, New York Life Investment Management expanded its alternative offerings by announcing a majority stake in Credit Value Partners LP in January 2017, and MassMutual acquired ACRE Capital Holdings, a specialty nance company engaged in mortgage banking.

Sub-sector highlights

Asian buyers diversifying their revenue base has had an impact on the life and annuity sector; regulations including the Fiduciary DOL Rule and the SIFI designation; and divestitures and disposal of underperforming legacy blocks (specifically, variable annuity and long term care).

The P&C sector has been experiencing a challenging pricing cycle, which has driven carriers to: 1) focus on specialty lines and specialized niche areas for growth and 2) consolidate. Furthermore, with an abundance of capacity and capital, the dynamics of the reinsurance market has changed. Reinsurers are trying to adjust by turning to M&A and innovating with new products and in new markets.

There has been a wave of insurance broker consolidation, largely because of the current low interest rate environment, which translates into cheap debt. The next wave of consolidation is likely to affect managing general agents because they have flexible and innovative foundations that set them apart from traditional 9% underwriting businesses.

According to PwC’s 2016 Global FinTech Survey, insurtech companies could grab up to a fifth of the insurance business within the next five years. In response, insurers have set up their own venture capital arms, typically investing at the seed stage, to keep up with new technologies and innovations and find ways to enhance their core businesses. Investments by insurers and their corporate venture rose nearly 20 times from 2013 to 2016.

See also: Minding the Gap: Investment Risk Management in a Low-Yield Environment  

Implications

  • Sale of legacy blocks: There is a continuing focus on exiting legacy risks such as A&E, long-term care, and variable annuities by way of sale or reinsurance. Already this year, there have been two significant transactions announced: AIG is paying $10 billion to Berkshire for long-tail liability exposure, and The Hartford is paying National Indemnity $650 million for adverse development cover for A&E losses.
  • Expansion of products: P&C insurers are focusing on expanding into niche areas such as cyber insurance, and life insurers are focusing on direct-issue term products.
  • Technology: Emerging technologies — including automation, robo-advisers, data analysis and blockchain — are expected to transform the insurance industry. Incumbents have been responding by directly investing in startups or forming joint ventures to stay competitive, and they will continue to do so.
  • Foreign entrants: Chinese and Japanese insurers have a keen interest in expanding to the U.S. market because of limited domestic opportunities and have the desire to diversify products and risk and expand capabilities.
  • Private equity/hedge funds/family offices: Non-traditional investors have a strong interest in expanding beyond the brokers and annuities businesses to other areas within insurance (e.g., MGAs).

M&A: the Outlook for Insurers

Mergers and acquisitions in the insurance sector continued to be very active in 2016 on the heels of record activity in 2015. There were 482 announced transactions in the sector for a total disclosed deal value of $25.5 billion. Deal activity was driven by Asian buyers eager to diversify and enter the U.S. market, by divestitures and by insurance companies looking to expand into technology, asset management and ancillary businesses.

We expect the strong M&A interest to continue, driven primarily by inbound investment.

With the election of a new president and the transition of power in January 2017 comes tax and regulatory uncertainty, which may temporarily decelerate the pace of deal activity. President Trump is expected to prioritize the repeal and replacement of Obamacare, tax reform and changes to U.S. trade policy, all of which have unique and potentially significant impact on the insurance sector. Further, the latest Chinese inbound deals have drawn regulatory scrutiny, with skepticism from the stock market regarding their ability to obtain regulatory approval.

Bond yields have spiked over the last few months and are widely expected to continue to increase. The increase in yields should improve insurance company earnings, which is likely to encourage sales of legacy and closed blocks.

Highlights of 2016 deal activity

Insurance activity remains high

Insurance deal activity has steadily increased since the financial crisis, reaching records in 2015 both in terms of deal volume and announced deal value. While M&A declined in 2016, activity remained high, with announced deals and deal values exceeding the levels seen in 2014. In 2015, deal value was driven by the Ace-Chubb merger, valued at $29.4 billion, which accounted for 41% of deal value.

See also: A Closer Look at the Future of Insurance  

Significant transactions

Key themes in 2016 include:

  • Continued consolidation of Bermuda insurers, with the acquisitions of Allied World, Endurance and Ironshore. Drivers of consolidation include the difficult growth and premium environment.
  • Interest by Asian insurers in continuing to expand their U.S. footprint — accounting for two of the top-10 transactions.
  • Expansion in specialty lines of business as core businesses have become more competitive. This is evidenced by (i) Arch’s acquisition of mortgage insurer United Guaranty as a third major business after P&C reinsurance and P&C insurance; (ii) Allstate’s acquisition of consumer electronics and appliance protection plan provider SquareTrade to build out its consumer-focused strategy; and (iii) the agreement by National Indemnity (subsidiary of Berkshire Hathaway) to acquire the largest New York medical professional liability provider, Medical Liability Mutual Insurance, a deal expected to close in 2017.
  • More activity in insurance brokerage, which accounts for two of the top-10 deals.
  • Focus on scaling up to generate synergies, as evidenced by the acquisitions done by Assured Guaranty and National General Holdings.
  • Continued growth in asset management capabilities, as exemplified by New York Life Investment Management’s expanding its alternative offerings by announcing a majority stake in Credit Value Partners LP in January 2017 and MassMutual’s acquiring ACRE Capital Holdings, a specialty finance company engaged in mortgage banking.

Key trends and insights

Sub-sectors highlights

Life & Annuity – The sector has been affected by factors such as Asian buyers diversifying their revenue base, regulations such as the fiduciary rule by the Department of Labor and the SIFI designation, divestitures and disposing of underperforming legacy blocks, specifically variable annuity and long term care businesses.

P&C – The sector has been experiencing a challenging pricing cycle, which has driven insurers to 1) focus on specialty lines and specialized niche areas for growth and 2) consolidate. We have seen large insurance carriers enter the specialty space. Furthermore, with an abundance of capacity and capital, the dynamics of the reinsurance market have changed. Reinsurers are trying to adjust to the new reality by turning to M&A and innovation in products and markets.

Insurance Brokers – The insurance brokerage space has seen a wave of consolidation given the current low-interest-rate environment, which translates into cheap debt. The next consolidation wave is likely in managing general agents, as they are built on flexible and innovative foundations that set them apart from traditional underwriting businesses.

See also: Key Findings on the Insurance Industry  

Insurtech has grown exponentially since 2011. According to PwC’s 2016 Global FinTech Survey, 21% of insurance business is at risk of being lost to standalone fintech companies within five years. As such, insurers have set up their own venture capital arms, typically investing at the seed stage, in efforts to keep up with the pace of technology and innovation and find ways to enhance their core business. Investments by insurers and their corporate venture arms are on pace to rise nearly 20x from 2013 to 2016 at the current run rate.

Conclusion and outlook

The insurance industry will be affected by the proposed policies of the Trump administration, especially on tax and regulatory issues. Increasing bond yields and the Fed’s latest signal about a quick pace of rate increases in 2017 are expected to improve portfolio income for insurers.

  • Macroeconomic environment: U.S. equity markets have been rallying since the election, with optimism supported by President Trump’s policies to boost growth and relieve regulatory pressures. However, the rally may be short-lived if policies fail to meet investor expectations. While the Fed is widely expected to raise rates in 2017, other central banks around the world are easing, and uncertainty in Europe has spread, with the possibility that countries will leave the euro zone or the currency union will break apart.
  • Regulatory environment: The direction of regulatory and tax policy is likely to change materially, as the president has campaigned for deregulation and reducing taxes. Uncertainty around the DOL fiduciary rule has been mounting even though President Trump has not spoken out on the rule; some of his advisers have said they intend to roll it back. His proposed changes to Obamacare will affect life insurers, but at this juncture it is hard to estimate the extent of the impact given the lack of specifics shared by the new administration.
  • Sale of legacy blocks: Continued focus on exiting legacy risks such as A&E, long-term care and VA by way of sale or reinsurance. In 2017, already, there have been two significant announced transactions, AIG paying $10 billion to Berkshire for long-tail liability exposure and Hartford paying National Indemnity $650 million for adverse development cover for A&E losses.
  • Expansion of products: Insurers will focus on expanding into niche areas such as cyber insurance (expected to be the fastest-growing insurance product fueled by a slate of recent corporate and government hacking). Further, life insurers are focusing on direct-issue term products.
  • Technology: Emerging technologies including automation, robo-advisers, data analysis and blockchain are expected to transform the insurance industry. Incumbents have been responding by direct investment in startups or forming joint ventures to stay competitive and will continue to do so.
  • Foreign entrants: Chinese and Japanese insurers have keen interest in expanding due to weak domestic economies, intent to diversify products and risk and hope to expand capabilities.
  • Private equity/hedge funds/family offices: Non-traditional firms have a strong interest in expanding beyond the brokers and annuities business to include other sectors within insurance, such as MGAs.

Will Startups Win 20% of Business?

Headlines about the insurtech disruption are split between issues like improvement to the customer experience and how traditional carriers expect to be affected. The situation is reminiscent of the days when Wal-Mart announced that a store was coming to a small town, and local retailers began screaming that the sky was falling.

We keep a close eye on insurtech at WeGoLook because, as a leader in the gig economy, we find natural partnerships abundant between our on-demand workforce and innovative insurtech services.

According to PwC Global, many insurance carriers see the potential downside to ignoring insurtech:

  • 48% of insurers fear that as much as 20% of their business could be lost to insurtech startups within the next five years;
  • Annual investment in insurtech startups has increased fivefold over the past three years, with total funding reaching $3.4 billion since 2010; and
  • More than two-thirds of insurance companies say they have taken concrete steps to address the challenges and opportunities presented by insurtech.

Will incumbent carriers accept the anticipated losses or will they fight to retain market share?

See also: Be Afraid of These 4 Startups  

The Standard Market’s Reaction

Traditional insurers have begun to throw a lot of money at the insurtech situation. Many of them have significant venture capital funds.

These steps are not necessarily being taken to compete with the startups that are expected to capture the 20% but to retain control over methods of distribution.

Even though insurtech startups appear to be better than incumbents at creating products and distribution systems, many still rely on their insurance partnership with standard carriers for underwriting and claims administration. New pay-per-use companies such as Metromile and Simplesurance, which are not regulated insurers, sell policies that are underwritten by established insurers.

A Threat to Distribution

Insurtech startups will take a significant bite out of the traditional insurance distribution system. Startups and incumbents will be forced into partnerships because both are vital to delivering products.

Insurers are certainly not blind to the opportunities that have become available as a result of technology that will allow them to learn more about the consumer experience and how the consumer behaves.

We’ve already seen carriers such as MetLife and Aviva found and support startup incubators. And even WeGoLook was recently acquired by Crawford & Co.

And this is a good thing!

If incumbent insurers can embrace and adapt to the innovation, creativity and agility of the startups, the insurance industry will be better positioned to meet the needs of the consumer.

The newly created partnerships are destined to make significant progress in solving the problems of the new economy and bring consumer-centric innovative products to the marketplace.

The New Competition Partners

Some of the startups that have already succeeded in taking a bite out of the traditional distribution system:

Oscar

Founded in 2012 with $750 million in venture capital, and one of the first to establish its presence, Oscar was created as a result of the Affordable Care Act. Oscar relies on technology and data so it can improve the healthcare it offers to customers. With annual revenue of $200 million, the company is currently valued at $3 billion.

See also: Top 10 Insurtech Trends for 2017  

Trov

Also founded in 2012, Trov is a U.S. startup funded with $46 million. The company was established to sell insurance by the piece.

The company will provide insurance on a per-item basis and offer policies on a term selected by the consumer.

Although founded in the U.S., the company first marketed its innovative product in Australia and targeted millennials. Like most other startups, the company partnered with a traditional insurer to handle the underwriting.

PolicyGenius

PolicyGenius is banking on consumers’ preference to have all their insurance products in one place and online.

The company was founded in 2014 with $21 million in capital and has partnered with major traditional players such as Axa, Transamerica and MassMutual.

As a virtual online insurance broker, PolicyGenius intends to make a dent in the insurance distribution system through satisfying the preferences of the consumer.

Metromile

San Francisco-based Metromile has created disruption in the auto insurance market by offering pay-per-mile auto insurance.

Through the use of an innovative app working in concert with the Metromile Pulse plug-in, consumers who use their vehicle on a limited basis will obtain significant savings on auto insurance.

The company offers a full customer service team and 24/7 claims service. All policies are underwritten via its partnership with National General Insurance Company (formerly GMAC).

Lemonade

After promising to reinvent the insurance industry, Lemonade offers home and renters insurance by using bots instead of brokers.

After testing the product in New York, the company launched nationwide in 2017. As licenses are approved on a state-by-state basis, the Lemonade footprint will continue to grow.

Unlike traditional insurers, Lemonade charges a flat-fee commission and then gives back unclaimed money to charitable causes that policyholders care about.

See also: Why I’m Betting on Lemonade  

Lemonade is a perfect example of how insurtech startups are revolutionizing the insurance industry.

But There’s Hope

Although the threat of losing market share is demonstrated by the success of many of the insurtech startups, it’s important to recognize that a relationship can manifest that benefits both traditional insurers and the innovative startup.

New business for one startup doesn’t necessarily mean a loss for another.

Also, traditional insurers are already positioned to raise the additional capital needed to compete with the startups — if they choose to do so.

So, will the 20% market loss actually be realized?

If we play our cards right, probably not.